Form 1120-S, and the four things that actually cause trouble

Reasonable compensation

A shareholder who works in the business has to be paid reasonable compensation for those services before taking distributions. Set it too low and the exposure is payroll tax, interest, and penalties on reclassified distributions. Set it arbitrarily high and you have paid employment tax you did not owe.

The defensible answer is a documented one: what the role would cost to replace, what the shareholder actually does, and what the company can support. We write down the reasoning, not just the number.

Stock and debt basis

Basis governs how much loss you can deduct and whether a distribution is tax-free. It moves every year with income, losses, contributions, and distributions, and it is tracked at the shareholder level, which means it is frequently tracked by no one.

Form 7203 is required with your individual return when you claim a loss, take a distribution, dispose of stock, or receive a loan repayment. Reconstructing basis a decade later, without contemporaneous records, is one of the more expensive projects in this practice. We keep the schedule current instead.

Distributions in excess of basis

Distribute more than your basis and the excess is generally taxable gain. This tends to surface in a profitable year following loss years, exactly when an owner is least expecting a tax bill on money already taken.

Elections, and getting them right the first time

• The S election itself. Filed late or filed wrong, and relief is often still available under Revenue Procedure 2013-30, but the request has to be built properly and it is not indefinite.
• Shareholder health insurance. Premiums for a more-than-2% shareholder must run through W-2 wages to be deducted correctly. Missing this is common and is fixable only inside the payroll year.
• State pass-through entity elections. Many states now allow the entity to pay state tax and deduct it federally. Whether that helps depends on your states and your facts, and it is an annual decision.
• Accountable plans. Reimbursing yourself for home office, mileage, and business expenses works when there is a plan and documentation behind it. Without one, the reimbursement is compensation.

Who this fits

Owner-operated S corporations, typically one to a handful of shareholders, with real payroll and real distributions. Professional practices, agencies, trades, consultancies, and e-commerce businesses that elected S status and now need the follow-through it requires.